Answer to Question #135921 in Microeconomics for nomcebo

Question

An appreciation of the rand against the dollar
(1) Will worsen the current account balance but improve domestic prices.
(2) Improve the current account balance but worsen domestic prices.
(3) Improve the current account balance as well as reduce domestic prices.
(4) Worsen both the balance on the current account as well as domestic prices.

Answer 1

Effects of Currency Appreciation

 

Answer is choice number (4) - Worsen both the balance on the current account as well as domestic prices.

 

An appreciation of the South African rand against the dollar will worsen the balance on the current account, as well as the domestic prices. A currency appreciates when its value goes up in comparison to another. Whenever a currency appreciates, that is, its value goes up; the demand for that currency also rises. When a currency appreciates, it affects the economy in various ways. First, it makes export costs to rise. For instance, when the rand appreciates, foreigners will find South African goods more expensive since they have to spend more dollars to buy those goods. Higher prices imply that fewer South African goods will be sold abroad, hence lower exports. Second, currency appreciation leads to cheaper imports. Appreciation of the rand increases its value, such that with less South African rand units, you can buy more dollar-worth of foreign goods than you would before the appreciation. The implication is that the lower price of imports will increase imports to South Africa. In a situation where imports are rising as exports decline, the balance on the current account worsens. The current account balance deteriorates because cheaper imports lead to an increased quantity of imports whereas expensive exports lead to a decreased quantity of exports. When a currency appreciates against another, imports become cheaper in the domestic, and this outcome exerts downward pressure on domestic prices. Therefore, appreciation of the rand against the U.S dollar not only worsens the South African balance on the current account but also its domestic prices.

Reference

Sharma, R. (2020). Currency Appreciation Definition. Retrieved 30 September  2020, from https://www.investopedia.com/terms/c/currency-appreciation.asp#:~:text=Currencies%20are%20traded%20in%20pairs,in%20comparison%20to%20the%20other.&text=If%20the%20value%20appreciates%20(or,which%20it%20is%20being%20traded.